Living on Leverage: Can U.S. Business Survive Its Passion for Debt?

By Gilbert, Nathaniel | Management Review, April 1990 | Go to article overview

Living on Leverage: Can U.S. Business Survive Its Passion for Debt?


Gilbert, Nathaniel, Management Review


You don't need all the pieces to see the picture in the puzzle. Those oddly shaped blue ones, for example, represent holders of corporate bonds that suffered $11.5 billion in defaults in 1989-up 136 percent over the previous year, according to the Bond Investors Association (BIA). There were 250 issues totaling $51 billion junk bonds" last year. According to Richard Lehmann, president of the BIA, about one third of the 38,000 bonds-with a value near $i trillion-now outstanding (including foreign and U.S. Treasury issues) are classified as junk."

Other pieces are bright red. They represent the number of U.S. bankruptcies last year almost 50,000-that left liabilities of more than $30 billion, according to Dun & Bradstreet's Department of Economic Analysis.

Notice that some of those red bankruptcy pieces represent bank failures-206 commercial banks and 47 savings and loan (S&L) institutions have gone belly-up-not to mention the hundreds of other submarginal S&Ls in legal limbo. They will end up costing American taxpayers at least $100 billion.

There are also big yellow pieces-the national debt: $2.972 trillion, as of January 5, 1990. It will cost the U.S. government approximately $260 billion just to service this debt this year, according to the U.S. Department of the Treasury.

Get the picture? You don't really need all the other puzzle pieces-the trade imbalance, the overextended federal budget, corporate debt and consumer credit-to see the image.

Why does America have such a passion for debt? Certainly, all debt isn't bad. In fact, debt is as much a part of capitalism as equity, and it is a vital ingredient in the building of virtually every business. To paraphrase Father Flanagan, "There are no bad debts-only bad debtors."

The leading advocate of debt is, for all practical purposes, the U.S. government. During the Great

Depression, the government adopted many of the concepts of John Maynard Keynes, a British economist. It was Keynes who developed the idea that governments could raise the level of national income through programs of public works. He showed that only a national government was capable of taking a long-term perspective and had the power to influence business activity for general social advantage.

Keynes was the spiritual father of Roosevelt's New Deal policies and, as an official of the British Treasury, negotiated the LeaseLend program during the early

days of World War II. This program enabled the United States to extend enormous credits to Britain to fund war materials. He also participated in discussions at Bretton Woods in 1944 that led to the establishment of the International Monetary Fund (IMF), and his ideas influenced the Marshall Plan for Europe and the rebuilding of japan after the war.

Keynes' concepts provided the theoretical basis for many of the social programs that have continued to this day-to "create" wealth by underwriting veterans' s, education, issue food stamps to S. the poor and contribute to the at United Nations and the IMF.

To no one's great surprise, corporate superdebt is another monster created by the government. Federal Reserve Chairman Alan Greenspan offers the key explanation. "Our tax system has long favored debt finance by taxing the earnings of corporate debt capital only at the investor level, while earnings on equity capital are taxed at both the investor and corporate levels," Greenspan told the U.S. House of Representatives Ways and Means Committee. "Evidence about the economic consequences of [corporate] restructuring is beginning to take shape. .. It is clear that the markets believe that the recent restructurings are potentially advantageous. Estimates range from $200 billion to $500 billion or more in paper gains to shareholders since 1982. ...This process could create a set of new problems for the financial system."

Greenspan also explained the opportunity to create economic value by restructuring companies, thus restoring what markets perceive as a more optimal mix of assets. …

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